Understanding the Co-insurance Provision in Commercial Property Policies

What is co-insurance?

Co-insurance is one of the most misunderstood and overlooked concepts in the world of commercial property insurance.  Some people believe it provides a way around having to insure the full replacement value of their property, while others believe it’s a way for the insurance company to wiggle out of paying the full amount of a claim.  Of course, neither of these viewpoints is entirely accurate.  Simply put, the Co-insurance provision requires the insured to maintain a limit of insurance equal to or greater than a stated percentage of the value of the property they own (traditionally 80% of 90%).  In exchange for accepting this responsibility, the insured receives a reduction in the applicable premium rate.

On the surface, Co-insurance appears to benefit the insured by reducing their premiums.  The problem however is that failure to meet the Co-insurance requirement will result in a penalty against the insured following a loss.

In other words, if the amount of insurance purchased is within the agreed Co-insurance percentage requirement, the loss is paid in full, up to the policy limit. BUT, if the amount of insurance carried is below the agreed percentage, the insured will be required to pay for a percentage of the loss; hence the name, Co-insurance.

This is a major cause for concern because most insureds are not equipped to accurately assess the replacement value of their property.  While replacement cost appraisals can help fill this void, they can be expensive while providing no guarantee to their accuracy.

To illustrate how Co-insurance can negatively impact an insured, consider the following scenario:

Let’s assume the full replacement cost of our property is $5,000,000, and that our insurance policy contains a 90% Co-insurance clause.  This means that we must carry at least $4,500,000 of coverage in order to avoid the Co-insurance penalty following a loss.  For the purpose of this example, let’s also assume that we mistakenly underinsured the property by only purchasing a limit of $3,000,000.  Now, we subsequently suffer an insured loss of $1,000,000.  The insurance company would pay the claim using the following formula:

In our example, the insurance company would only pay $666,667 of the $1,000,000 loss, leaving us to cover the remaining $333,333.

This example illustrates the danger Co-insurance creates for insureds, particularly those that are not well-equipped to accurately assess and manage the replacement value of their property today and into the future.

Stated Amount/ Agreed amount

Insurers may agree to waive or suspend the Co-insurance clause within their policy through the addition of an Agreed Amount (USA) or Stated Amount (Canada) endorsement.  In order to add the endorsement, the insurers typically require either a signed statement of values from the insured or the completion of a recent replacement cost appraisal.  Once added, the stated amount co-insurance clause effectively acts as an agreement that the insurer has accepted the declared values as being accurate and therefore, will not impose a co-insurance penalty following a loss.

When insuring your property, we recommend working with your broker or consultant to remove any Co-insurance penalty from your policy.  Failing this, it is critical that insureds assess and declare an accurate replacement cost value.  Under-insuring your property can leave you exposed to a hefty shortfall should a loss occur. While the premium savings may be tempting, failure to properly manage the Co-insurance provision could lead to a devastating effect in the event that a claim arises.

For more information on Co-insurance or Stated Amount, please contact:

Gordon Tulloch BA
Risk Analyst – Lender Insurance Services
gtulloch@intechrisk.com

About INTECH:

INTECH Risk Management (“INTECH”) is an independent insurance consulting company involved in the analysis, design, development, implementation and management of insurance programs. INTECH does not sell insurance, nor is it affiliated with any insurance company or brokerage.  This unique independent position in the marketplace enables our consultants to avoid conflicts of interest and provide our clients with unbiased, expert advice. INTECH has received the 2017 Award for Excellence in Risk Management from Insurance Business Canada, the 2015 and 2016 Due Diligence Provider of the Year Award from IJGlobal Americas, and has achieved Platinum Elite Status on ReNew Canada’s Top100 Projects.